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Foolish Forecast: Infosys Doesn't Compute

10 times sales? Who'd pay that?

It's not that I don't agree with the analysts, mind you. Sure, it's entirely possible that when Indian IT outsourcing king Infosys(NASDAQ:INFY) reports its fiscal Q3 2005 earnings numbers tomorrow after market close, the firm will meet estimates of $0.52 per share in profit. Yes, it's possible that it will, as a result, grow its profits by 30% year over year -- nearly matching its 32% projected sales growth.

Heck, the firm might even beat estimates. It's done so three times in the past four quarters, and it's entirely possible that the firm will do it again. But as well as the business is performing, Infosys stock has a built-in defect that should make Fools think twice before investing.

According to Capital IQ, Infosys currently sports a local market capitalization of 832.9 billion India Rupees (INR). That works out to about $18.8 billion. With trailing 12 months' (TTM) sales of 80.2 billion INR and 21.4 billion INR in TTM profits, the firm therefore sells for 10.4x sales and 38.9x profits.

I admit, the former multiple seems a bit high to me when you consider that Computer Associates(NYSE:CA) trades at 4x sales, Oracle(NASDAQ:ORCL) at 5x sales, SAP(NYSE:SAP) at 6x, and Motley Fool Inside Value pick Microsoft(NASDAQ:MSFT) at 7x.

But hey, I get it. None of these firms is growing its revenues at a 30% rate, and so Infosys, which is setting that barn-burning pace, deserves an appropriately premium valuation for that growth.

But the key word there is "appropriately." Is it fair to pay 39x profits for a company growing at 30%? Perhaps it is. The problem is that an individual investor here in the U.S. doesn't pay 39x profits. As a result of India's restrictions on foreign ownership constricting the supply of Infosys's American depositary receipts on the NYSE, those ADRs actually retail for closer to 46x profits. Were the company priced in INR at the same valuation that its ADRs fetch in New York, Infosys would sport a total valuation of $22.3 billion dollars -- 18% greater than the company's worth on an Indian exchange.

So, yes, Infosys is growing fast. And yes, its 27% profit margin does entice. But this Fool's sensibilities rebel at the idea of investing in equities with this kind of dual pricing structure. It's the same reason I haven't yet invested in Russia's Gazprom (until recently, Gazprom's ADRs retailed for a 40% premium to the shares' domestic price). Russia has taken steps to free up trading in Gazprom's shares, but until India follows suit, investing in Infosys just doesn't compute.

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Fool contributor Rich Smith has no position in any company named above.

Author

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.